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The Most Overvalued Stocks in the Market

It's increasingly clear that it's the beginning of the end of
the recent
market
rally. The major indexes have moved steadily higher since Oct. 1,
2011, with some of the more speculative stocks becoming the biggest
gainers. These stocks weren't cheap to begin with, so now they're
really quite pricey.

In the weeks and months ahead, the market may still trend higher,
but investors will likely take an increasingly defensive posture,
gravitating toward more reasonably-priced stocks. For the market's
biggest recent winners, trouble could be ahead.

I went looking for stocks that have a price/earnings to growth (
PEG
) ratio above 1.0, which means that the P/E ratio on projected 2013
profits is even higher than the projected
earnings
growth rate. Every one of these stocks has risen at least 30% since
Oct. 1, trades for at least 35 times projected 2013 profits and
sports a PEG ratio above 1.0. (In some instances, 2012 profits will
likely be negative, making a PEG ratio hard to calculate.)

Some of these stocks were heavily shorted to begin with, and
short covering
simply pushed them much higher. Other stocks have delivered solid
quarterly results, encouraging investors to embrace high-growth
(but also high P/E) stocks. Yet with the U.S.
economy
still looking just OK (recent economic reports have been a bit more
sobering), investors may soon shift gears and start avoiding the
highest P/E stocks.

You'll also notice that several of the stocks in this table are
from the software-as-a-service segment, which comprises companies
that charge clients on a recurring basis to manage their
information on secure sites. These companies, including
SourceFire (Nasdaq: FIRE)
,
Netsuite (
N
)
,
CornerstoneOnDemand (Nasdaq: CSOD)
and
Concur Technologies (Nasdaq: CNQR)
, have been posting phenomenal growth rates in recent quarters. The
key concern: their revenue bases are much larger now, so
year-over-year growth rates will likely start to drop. The fact
that each stock trades for more than 40 times projected 2013
profits leaves them quite vulnerable to any signs of a slowing
market. Simply put, the risk is perhaps now greater than the reward
in buying these
shares
.

Also in the tech realm, you'll find cloud-computing stocks
Rackspace Holdings (
RAX
)
and
InterNAP (Nasdaq: INAP)
-- companies that
offer
outsourced server management capabilities. Analysts at Dougherty
& Co say Rackspace has moved into
overvalued
territory. The company is expected to post an impressive 30% jump
in sales this year to $1.3 billion compared with 2011, and another
25% in 2013 to roughly $1.65 billion. They figure this high-growth
platform is worth a pretty robust 10 times projected 2012
EBITDA
. They even concede that another company may acquire Rackspace, so
they use a multiple of 12, which is pretty high, to determine their
price target
, and this equates to a share price of $40. Shares have already
shot past this mark, however, and are in the low $50s.

Perhaps the most overvalued name in this group is online vitamin
distributor
Vitacost.com (Nasdaq: VITC)
. The company struggled out of the gate after completing a late
2009
IPO
, eventually needing to replace its management team. Even as sales
rose steadily throughout 2010, a series of snafus led to
operational inefficiencies, pushing EBITDA into negative territory.

CEO
Jeffery Horowitz took the reins in the summer of 2010 and has been
slowly working the kinks out of the company's
business model
(though it has yet to post an
operating profit
). The company will release fourth-quarter results on March 15, and
it's likely to report incremental progress on its march back to
profitability. Analysts say the company may finally turn a
profit
by the second or third quarter of 2012, and full-year profits by
2013.

Even so, the stock seems to have gotten ahead of itself. It
trades at roughly 35 times projected 2013 profits, which is more
than twice the multiple sported by vitamin-selling rival
GNC (
GNC
)
. The vitamin business is largely mature, so hopes that Vitacost
can "grow its way into the multiple" in 2014 and beyond appear
misplaced.

Risks to Consider:
If the market keeps chugging even higher, then investors may
"let these winners ride," making them too risky to short.

Action to Take -->
The market is changing, and what has worked in recent months is
unlikely to keep working in the months ahead. This means you should
be harvesting profits on these now-pricey stocks if you own any of
them. Those who are feeling somewhat bold might want to look into
shorting some of the stocks I've mentioned.

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-- David Sterman

David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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